Feb 17, 2025 · 59m · capital-allocators
Michael Choe - Atomization of Private Equity Decisions at Charlesbank (EP.432)
0:00 / 0:00
gold bands on the timeline = statements, start to end. Hover to read, click to jump. CC turns on captions
In this episode of Capital Allocators, host Ted Seides interviews Michael Choe, CEO of Charlesbank Capital Partners, exploring how the firm transforms private equity investing into a systematic, probabilistic decision-manufacturing process. Choe discusses his unique personal background, the flaws of traditional five-year LBO underwriting, and Charlesbank's proprietary 'Two-Year Fan of Outcomes' Monte Carlo framework for unlocking asymmetric upside and institutional excellence.
How this conversation actually went
Every chapter scored 0–10 on four independent dynamics. Hover any point for the reasoning behind the score. Ted holds 18.1% of the talking time here. How this is scored →
Ted as informed peer 2.6 Guest teaching 3.7 Guest disagreement 0.5 Ted pushing back 0.0
speaking balance: gold is Ted, purple is the guest (3 minute bins)
Sharpest disagreement ▶ 21:28 Tearing down 5-year LBO model conventions
Mike vigorously critiques the industry standard 5-year LBO model as fundamentally flawed, arguing it manufactures false precision and masks real outcome dispersion.
Hardest push from Ted ▶ 37:25 Ted pressing on empirical drivers of successTed presses Mike to move beyond the modeling theory and provide concrete empirical proof of what historical factors actually drove Charlesbank's investment performance.
Biggest teaching moment ▶ 30:20 Probabilistic math on customer retention riskMike gives a clear mathematical demonstration showing how deal teams deceive themselves on sticky accounts, proving two 90% probabilities compound to a 1/3 risk of losing a client over two years.
Ted holds their own ▶ 13:40 Ted contextualizing Harvard Management Company's spinoutsTed highlights his deep allocator expertise by contrasting Jack Meyer's in-house investment model at Harvard with David Swensen's third-party manager model at Yale.
the scores for every segment, with the reasoning behind each
| Chapter | Topic | Ted as informed peer | Guest teaching | Guest disagreement | Ted pushing back | Why |
|---|---|---|---|---|---|---|
| Episode Overview and Host Monologue | 1 | 2 | 0 | 0 | Host sets up the episode in monologue before asking about Mike's early childhood background. Mike shares his unexpected move back to Korea and adapting to a different educational system. | |
| Parental Influences, Logic vs. Decisiveness, and Decision Studies | 2 | 3 | 0 | 0 | Ted probes how parental influences shaped Mike's view of decision-making. Mike explains the contrast between his logical but indecisive father and decisive mother. | |
| Career Transition from Science to McKinsey and Charlesbank | 4 | 3 | 0 | 0 | Ted demonstrates solid institutional knowledge regarding Jack Meyer and Harvard Management Company's in-house model versus Yale. Mike elaborates on the spinout history of Charlesbank. | |
| Evolution of Investment Philosophy: Manufacturing Sound Decisions | 3 | 4 | 1 | 0 | Mike explains shifting away from crude valuation heuristics toward viewing the firm as a decision-manufacturing engine where the atomic unit of production is a decision. | |
| Shifting from EBITDA Multiples to Two-Year Probability Distributions | 3 | 4 | 1 | 0 | Mike deconstructs the industry-standard TEV/EBITDA metric, explaining why cash flow yield assumptions fall apart in modern PE exits and introducing the 2-year forward probability distribution. | |
| Flaws of 5-Year LBO Models and the 2-Year Fan of Outcomes | 3 | 5 | 2 | 0 | Mike challenges standard industry practice, pointing out how 5-year LBO models promote severe anchoring bias and uncalibrated base cases compared to actual wide outcome dispersion. | |
| Probabilistic Modeling, Accountability, and Asymmetric Upside KPIs | 3 | 5 | 1 | 0 | Mike educates on replacing base/bull/bear stories with Monte Carlo KPIs, tracking the percentage of simulated paths yielding >30% IRR or capital impairment to target upside asymmetry. | |
| Quantifying Unseen Risks: Recessions and Customer Concentration | 3 | 5 | 1 | 0 | Mike explains how traditional modeling hides compound risk, demonstrating how two independent 10% annual customer churn risks compound to a 33% chance of losing a top account across two years. | |
| Sponsor Message: AI-Native Investment Operations with Ridgeline | 2 | 1 | 0 | 0 | Segment includes a mid-roll advertisement read followed by Ted prompting how downstream modeling shapes upstream origination workflows. | |
| Identifying Asymmetric Opportunities in Specialized Human Capital Services | 2 | 4 | 0 | 0 | Mike details targeting CPA and tax accounting firms due to strong customer retention, capital efficiency, and misunderstood income scrape mechanics. | |
| Empirical Regression Findings on M&A, Management, and Entry Multiples | 3 | 5 | 1 | 0 | Mike shares empirical regression findings that debunk common industry assumptions, noting no correlation between entry multiples and returns, and strong returns from programmatic M&A. | |
| Implementation Obstacles and Portfolio Company Communication | 3 | 4 | 0 | 0 | Mike discusses practical hurdles in probabilistic modeling, including avoiding over-complexity and distinguishing bad luck in tail events from flawed decision logic. | |
| Measuring Model Efficacy via Portfolio Breakout Performance | 3 | 4 | 0 | 0 | Mike outlines tracking breakout returns across recent vintages and applying asymmetric decision framing to internal talent retention and firm expansion. | |
| Evaluating the Evolution and Valuation Dynamics of Private Equity | 3 | 4 | 1 | 0 | Mike analyzes structural shifts in private equity valuations, plateauing entry multiples, and liquidity cushions supported by massive global private capital allocations. | |
| Macro Debt Cycle Risks vs. Excitement for Talent Science | 2 | 3 | 0 | 0 | Discussion moves from macro debt restructuring risks to rapid-fire personal questions including cooking, tutoring in Seoul, and books on near-death experiences. | |
| Building a Systematic, Enduring Investment Institution | 2 | 3 | 0 | 0 | Mike closes by detailing the firm's vision of building an enduring institutional decision system rather than relying on star individuals. |
Statements from this episode (24)
Choe: Harvard built direct in-house investment teams while Yale selected external managers
“So in contrast with Yale, where David Swenson pioneered the use of third-party managers to generate performance and manager selection, and then also overweighting into alternatives, Harvard decided to construct Their portfolio with in-house investors, and so t…”
Choe: Simple valuation multiple heuristics fail in private equity
“The problem with that type of simple heuristic, where you go for certain multiples, is that especially given the dynamic evolution of the private equity industry over this last couple decade period, It's often the case that it's not dynamic or nuanced enough a…”
Choe: Charlesbank treats investment management as a decision-manufacturing process
“And so we tend to think about our firm as a manufacturing process where the atomic unit of production is a decision. Now, some of those decisions are final investment decisions, but really everything we do leading up to a final investment decision is the produ…”
Choe: PE portfolio companies are mostly exited to buyers, not sold on cash yield
“Today where private equity portfolio companies are by and large exited to other buyers, so they're not really being sold on free cash flow yield.”
Choe: Charlesbank values assets via two-year earnings probability distributions
“What we decided to do was to expand our view of what the underlying value of an asset was from the simple snapshot of how much free cash flow is generating at a point in time to a point of view around within the first two years of our ownership, what is the pr…”
Charlesbank requires checklist review before spending over 20 hours on deal ideas
“Within our origination and sourcing process, there's typically three stages. There's no real genius to how we stage gated them. It's really something pretty speculative anybody can work on, but it's a pretty small number of hours that we'll authorize for that.…”
Choe: Standard 5-Year LBO Models Promote Anchoring and Familiarity Biases
“We're using a highly flawed tool that actually promotes all kinds of predictable human biases. There's anchoring bias, there's familiarity bias, to make a decision that is inherently very difficult to make. Because what we're really doing is we are underwriter…”
Charlesbank Models Investments Using 10,000-Simulation 2-Year Monte Carlo Analysis
“We have, as a result, shifted all of our modeling to a homegrown proprietary tool that we call our two-year fan of outcomes. It's basically a fairly simplified Monte Carlo analysis. It runs 10,000 simulations of the two year forward future of any given investm…”
Choe: Two-Year Pre-Tax Earnings Growth Strongly Predicts PE Investment Success
“When we ran our regression analysis, our ability to grow the pre-tax earnings of a company within the first two years of our ownership was highly correlated and very predictive of ultimate investment success, no matter how long the hold period was.”
Choe: Perceived PE Management Quality Is Mostly a Spurious Correlation
“You don't really know management quality when you first come to an investment. You actually develop your view of their quality depending on how that investment's going, so that's sort of a spurious correlation.”
Choe: Charlesbank Targets Asymmetric Upside Distributions Over High Base Cases
“Rather than looking at things that have a high base case, what we're looking for now are companies that have a very asymmetric distribution of outcomes towards the upside with very muted downside.”
Choe: Charlesbank models a 12% annual recession probability for underwriting
“The thing we now do, if a business is severely recession exposed, we have a generic probability of a recession. It's 12% in any given year. We could be wrong about that, but it's better than not putting a probability in. So we say, okay, well, let's just assum…”
Choe: Charlesbank Shifted Sourcing Away From Availability Toward Asymmetric Profiles
“What we have noticed is that there's been a shift away from filtering investments using availability. There's always a part of somebody's brain when they're looking at investments around, how do I make sure that I don't waste too much time? How do I look for c…”
Choe: Specialized human capital services can match software returns on capital
“In this decade, we think there are classes of companies out there that offer human capital services that are highly specialized, that have pricing power, that have the ability to generate very attractive margins, that are incredibly asset light and very capita…”
Choe: US CPA industry is a $40 billion market before advisory revenue
“And so an example of that would be the USCPA industry. It's a Forty billion dollar industry before accounting for surrounding advisory revenue that typically goes along with having an audit or a tax practice.”
Choe: Inorganic earnings growth correlates with PE returns almost as strongly as organic
“And startlingly, the R squared on total Earnings growth is almost as strong as organic growth only, and I think the reason for that is that when a company is approving acquisitions and we're obviously in control of that decision, we're typically doing it with …”
Choe: Management stability shows little correlation with private equity investment success
“Another one would be that we used to think that management stability would be very correlated with investment success, and we looked at changes in C-suite management, and there was really not a ton of correlation there, so I'd say that's been an insight that h…”
Choe: Charlesbank found lower entry multiples correlate with weaker private equity returns
“And in our case, and we really had the data just to look at the hundred or so transactions in our history as a private equity firm, there was really no correlation. If there was one, it was a very weak negative correlation. So lower multiple investments tended…”
Choe: Action bias strongly correlates with high performance at Charlesbank
“One of the factors that is very dominantly correlated with being a high performer at Charles Bank is something called action orientation or action bias in the personality tool that we use.”
Choe: Charlesbank has only expanded into business adjacencies twice in 30 years
“This is why in nearly 30 years of being a private equity firm, we've only done that twice.”
Choe: Average North American Buyout Free Cash Flow Yield Is Low Single Digits
“The average free cash flow yield of a North American buyout is in the low single digits now, and so it's no longer really Supposed to be a metric for free cash flow.”
Choe: Trillions in Global Capital Create a Valuation Floor for Private Equity
“We do think there is a little bit of a floor or a cushion to valuation mean reversion risk because of the fact that there's just trillions of dollars of global capital that wants to get allocated to private equity that will create a bit of a technical floor to…”
Choe: 2021 leverage excesses will cause restructurings over coming years
“We think a lot of the leverage excesses of 21 are likely to result in first liability management exercises, LMEs, that will then involve some amount of restructuring over the next few years or so.”
Choe: Systematic Process in Investing Is Far Harder Than Star Talent
“I think it's much easier to have a firm that is a great investment firm because it has one or two great investors. Now, I'm not saying we are that, but just take any famous investment firm out there, Hedge Fund or Berkshire Hathaway. Really, the persona of the…”